But Why?  And Who Is Being Fooled By Whom?

One of the bright spots in the economy – perhaps the only one – has been the renewed profitability of investment banks.  But a recent story on The Daily Beast suggests that the picture is misleading – if not illusory.

Nomi Prins describes in detail the various accounting tricks that the big banks have resorted to in order to inflate their profits:  most of them have changed their reporting periods, so it is now virtually impossible to compare this year’s figures with last year’s;  then they have massively reclassified their debts and assets;  finally, the mergers and acquisitions that have occurred have melded together (or not) quite different accounting procedures and sets of figures.  It’s a mess – but it’s a mess that has been made to look good because trading profits have been emphasized and credit losses disguised.

It is not hard to figure out why they want to create this appearance of financial health.  It will help persuade investors to trade with them, and, as they are in fierce competition with each other, their relative profitability will attract yet more money.  An additional motive is to pay back their TARP loans, so they can get out from under federal supervision for their compensation policies.

It’s worth noting that the one thing none of them seem eager to do is lend money to small businesses.  That would really help the economy as a whole as it would increase productivity and add to jobs, but that does not generate the quick profits they are seeking.

Prins concluded: “Trading profitability, albeit inconsistent and volatile, is the quickest way back to the illusion of financial health, as these banks continue to take hits from their consumer-oriented businesses. But, appearance doesn’t equal stability, or necessarily, reality.” (See, “Worse Than Enron.”)

This is crafty and deceptive, but it is not unconscious.  One might argue it is an essential part of our competitive system, and those who are playing the game know it very well.  But what is unconscious and truly dangerous here is that high levels of risk are being minimized all over again.  To be sure, sub-prime mortgage derivatives are no longer driving the market, and AIG is no longer supporting the illusion of insurance against loss.  But, as Pins notes, “appearance doesn’t equal stability.”

She argues that a greater degree of transparency is required:  “we need an objective, consistent evaluation of bank balance sheets complete with probing questions about trading and speculative revenues, allowing for comparisons across the banking industry.”  That will help regulators check what is really happening.  But it could also be a reality check for those who, caught up in the relentless competitive drive for profits, will want to keep on betting the farm and, once again, put us all at risk.